Profit

What is Profit?

Profit is the value remaining after a company’s expensesExpensesAn expense is a type of expenditure that flows through the income statement and is deducted from revenue to arrive at net income. Due to the accrual principle in accounting, expenses are recognized when they are incurred, not necessarily when they are paid for. have been paid. It can be found on an income statementIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.This statement is one of three statements used in both corporate finance (including financial modeling) and accounting.. If the value that remains after expenses have been deducted from revenue is positive, the company is said to have a profit, and if the value is negative, then it is said to have a loss (see: P&L statementProfit and Loss Statement (P&L)A profit and loss statement (P&L), or income statement or statement of operations, is a financial report that provides a summary of a company's revenues, expenses, and profits/losses over a given period of time. The P&L statement shows a company's ability to generate sales, manage expenses, and create profits.). Other terms that mean the same thing are earnings and income.

Types of Profit

There are three common measures of profit:

1. Gross Profit

Gross profit is the value that remains after the cost of sales, or cost of goods sold (COGS)Cost of Goods Sold (COGS)Cost of Goods Sold (COGS) measures the “direct cost” incurred in the production of any goods or services. It includes material cost, direct labor cost, and direct factory overheads, and is directly proportional to revenue. As revenue increases, more resources are required to produce the goods or service. COGS is often, has been deducted from sales revenue. This is typically the first sub-total on the income statement for most businesses.

2. Operating Profit

Operating profit, also called Earnings Before Interest and Taxes (EBIT)EBIT GuideEBIT stands for Earnings Before Interest and Taxes and is one of the last subtotals in the income statement before net income. EBIT is also sometimes referred to as operating income and is called this because it's found by deducting all operating expenses (production and non-production costs) from sales revenue., is the value that remains after all operating expenses have been deducted from revenue. This is typically the second sub-total on the income statement.

Examples of operating expenses include sales expenses, marketing, advertising, salaries and wages, employee benefits, depreciation, rent, commissions, and any other costs that relate to the ongoing operations of the business.

3. Net Profit

Net profit (also called net incomeNet IncomeNet Income is a key line item, not only in the income statement, but in all three core financial statements. While it is arrived at through the income statement, the net profit is also used in both the balance sheet and the cash flow statement. or net earnings) is the value that remains after all expenses, including interest and taxes, have been deducted from revenue. This is the final figure located at the bottom of the income statement.

The net earnings figure includes non-operating expenses such as interest and taxes. It can also be referred to as net income.

Example of Profit

Below is a screenshot of Amazon’s 2017 statement of operation (income statement) from CFI’s Advanced Financial Modeling Course. As you can see, Amazon doesn’t have a gross income subtotal, but it does have an operating income and a net income.

For 2017, by taking net sales of $117.9 billion and subtracting operating expenses of $173.8 billion, you will arrive at the operating income of $4.1 billion. Then, to get to the bottom line, subtract from the amount of interest, taxes, and any other expenses to arrive at the net income of $3.0 billion.

As mentioned previously, it is not a requirement to have a gross profit subtotal, as is the case with Amazon.

Cash Flow vs. Profit

Cash flow and profit are both important metrics when evaluating a company’s performance, and each has its pros and cons as a metric.

Cash flow measures the actual value of cash generated by a company, while income is an accounting figure that uses the accrual principleAccrual PrincipleThe accrual principle is an accounting concept that requires transactions to be recorded in the time period during which they occur, regardless of the time period when the actual cash flows from the transaction are received. The idea behind the accrual principle is that financial events involve matching revenues.

Characteristics of cash flow:

Shows the actual change in cash over a period of time

Used in financial modelingWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company's financial performance. Overview of what is financial modeling, how & why to build a model. and business valuation to calculate the intrinsic valueIntrinsic ValueThe intrinsic value of a business (or any investment security) is the present value of all expected future cash flows, discounted at the appropriate discount rate. Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own. of a firm (see CFI’s Financial Analyst Courses to learn more!)

Can be lumpy and uneven depending on the timing of cash inflows and outflows

Characteristics of profit:

Shows a “smoother” picture of a company’s expenses over time

Uses accounting principles such as revenue recognitionRevenue Recognition PrincipleThe revenue recognition principle dictates the process and timing by which revenue is recorded and recognized as an item in a company's financial statements. Theoretically, there are multiple points in time at which revenue could be recognized by companies., matching, and accruals

Includes non-cash expenses such as depreciationDepreciation MethodsThe most common types of depreciation methods include straight-line, double declining balance, units of production, and sum of years digits. There are various formulas for calculating depreciation of an asset. Depreciation expense is used in accounting to allocate the cost of a tangible asset over its useful life., impairment charges, and stock-based compensationStock Based CompensationStock Based Compensation (also called Share-Based Compensation or Equity Compensation) is a way of paying employees and directors of a company with shares of ownership in the business. It is typically used to motivate employees beyond their regular cash-based compensation and to align their interests with those of the company.

Additional Resources

Thank you for reading this guide to understanding the various metrics of income. CFI is the official provider of the Financial Modeling & Valuation Analyst (FMVA)®FMVA® CertificationJoin 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari designation, designed to transform anyone into a world-class financial analyst. To learn more, these additional CFI resources will be helpful:

Depreciation MethodsDepreciation MethodsThe most common types of depreciation methods include straight-line, double declining balance, units of production, and sum of years digits. There are various formulas for calculating depreciation of an asset. Depreciation expense is used in accounting to allocate the cost of a tangible asset over its useful life.

Fixed and Variable CostsFixed and Variable CostsCost is something that can be classified in several ways depending on its nature. One of the most popular methods is classification according to fixed costs and variable costs. Fixed costs do not change with increases/decreases in units of production volume, while variable costs are solely dependent

Projecting Income Statement Line ItemsProjecting Income Statement Line ItemsWe discuss the different methods of projecting income statement line items. Projecting income statement line items begins with sales revenue, then cost

SG&A ExpensesSG&ASG&A includes all non-production expenses incurred by a company in any given period. This includes expenses such as rent, advertising, marketing, accounting, litigation, travel, meals, management salaries, bonuses, and more. On occasion, it may also include depreciation expense